Remittances and the Dutch Disease

Using data for El Salvador and Bayesian techniques, we develop and estimate a two-sector dynamic stochastic general equilibrium model to analyze the effects of remittances in emerging market economies. We find that, whether altruistically motivated or otherwise, an increase in remittance flows leads to a decline in labor supply and an increase in consumption demand that is biased toward nontradables. The higher nontradable prices serve as incentive for an expansion of that sector, culminating in reallocation of labor away from the tradable sector; a phenomenon known as the Dutch disease. Quantitative results also indicate that remittances improve households'welfare as they smooth income flows and increase consumption and leisure levels. A Bayesian vector autoregression analysis provides results that are consistent with the dynamics of the model.

JEL classification: F40, F41, O10

Key words: Dutch disease, real exchange rate, remittances

The authors thank Enrique Mendoza, Kolver Hernández, Peter Ireland, Gabriel Montes-Rojas, José Pineda, Rob Vigfusson, Diego Vilán, Carlos Zarazaga, and seminar participants at the Inter-American Development Bank, the Atlanta Fed, the SCIEA meetings at the Philadelphia Fed, California State University-Fullerton, LACEA-LAMES, SEA, CCMS, the University of Torcuado Di Tella, the Central Bank of Argentina, and the Central Bank of the Philippines for helpful comments. Sergio Guerra and M. Laurel Graefe provided superb research assistance. The views expressed here are the authors'and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, or Corporación Andina de Fomento. Any remaining errors are the authors'responsibility.